Valuation Method #1: Re-thinking Multiple of Earnings

One of the most common methods investment bankers and business brokers use to value companies is called the multiple of earnings approach. They use past transaction data to arrive at a composite average “multiple” that they apply to businesses with similar revenue and earnings.

Digging just below the surface, business owners should re-think the reliance they place on this method. It may not be the right one for the most important economic transaction of their lifetime.

Here are just a few questions that warrant further conversation:

1) Will owners with businesses that are similar to companies 1 & 2 sell for four times earnings if they allow a broker to “take them to market” on the basis of a multiple of earnings valuation?
2) What made the difference in the outcome for the owners of companies 2, 3 & 4? Each company had similar earnings.
3) If the post-sale lifestyle needs of the owner of company 5, only required a $4,000,000 sale, would they have realized a $5,000,000 transaction?

These and other hard questions deserve an owners thoughtful consideration.

In a separate post, the economic interests of brokers and how they do; or, don’t, align with the owners they are representing will be highlighted.